Fed worries about international risks to US economy

[WASHINGTON] The Federal Reserve worried about foreign risks to the US economy but could raise interest rates despite weaker-than-desired inflation, according to the minutes of the last meeting published Wednesday.

"Many participants regarded the international situation as an important source of downside risks to domestic real activity and employment," said the minutes of the December 16-17 meeting of the Federal Open Market Committee (FOMC).

The potential for weaker US economic growth would rise "particularly if declines in oil prices and the persistence of weak economic growth abroad had a substantial negative effect on global financial markets," the minutes said, "or if foreign policy responses were insufficient." The outlook for growth in the eurozone, Japan and China has dimmed and slumping oil prices are battering the economies of Russia, Venezuela and other oil-exporting countries.

The final 2014 meeting of the Fed's policy arm came amid a plunge in oil prices since June that has further deepened, more than halving the value of crude oil to below US$50 a barrel currently.

The sharp fall in oil has roiled financial markets, especially in the first trading days of the year, as investors worry about weaker demand in a slowing economy and a global oil supply glut.

But the FOMC, in its December discussion of when to start raising the federal funds rate, pegged near zero for six years to support the recovery from deep recession, saw a boon from lower oil prices.

A few participants said the effect was likely to be positive on overseas employment and economic growth.

For the US economy, several participants expected slower economic growth abroad to curb the US economy, mainly through lower net exports.

"But the net effect of lower oil prices on US economic activity was anticipated to be positive." The policymakers saw "broad-based improvement" in the labor market since their October 28-29 meeting, with solid gains in job growth, a small reduction in the unemployment rate and increased hiring.

But despite the labor gains and the economy growing at a "moderate" pace, "most participants saw no clear evidence of a broad-based acceleration in wages." Inflation running well below the Fed's longer-term 2.0 per cent target was expected to rise gradually to the comfort zone as officials expected the labor market would continue to improve and the "transitory" effects of lower oil prices and other factors would fade.

"The risks to the outlook for economic activity and the labor market were seen as nearly balanced."

The policymakers indicated that the Fed may raise rates even though inflation remained below target.

"With lower energy prices and the stronger dollar likely to keep inflation below target for some time, it was noted that the Committee might begin normalization at a time when core inflation was near current levels, although in that circumstance participants would want to be reasonably confident that inflation will move back toward 2 per cent over time," the minutes said.

The central bank's preferred inflation measure, the personal consumption expenditures price index, was up 1.2 per cent in November from a year ago, while core PCE increased less than 0.1 per cent.

"The Fed is determined to tighten, though several participants urged for more data-dependent criteria so that investors would get away from a conviction the hike will be in the middle of the year. The Fed may hike rates even if headline inflation runs well below target for a time," said Chris Low of FTN Financial.

According to the minutes, "most participants" agreed to adding language in the FOMC statement about being patient in deciding to raise interest rates, saying it indicated the process was unlikely to begin "for at least the next couple of meetings." That suggested the first rate hike could come earlier than expected, perhaps as soon as April, after the January and March meetings, said Omer Esiner of Commonwealth Foreign Exchange.

AFP